Console Wars Heating Up

With Nintendo's Wii U now more than a year old, the two remaining members of the triopoly of video game console makers - Microsoft and Sony - are now vying for market share with the latest versions of their signature consoles. To that end, both multinationals have relied on new features, expanded capabilities, and when all those begin to look homogenous, the old standby of undercutting.

Late last November, Microsoft and Sony released the Xbox One and the PlayStation 4 respectively. It’s to both companies’ credit that they and Nintendo have quickly dominated a market that used to be the province of other, since-vanquished players.

The Numbers

In its brief lifetime, the PlayStation 4 has sold six million units. The Xbox One has sold barely half that. Ceteris paribus, that’s largely a result of price: hard drive capacity, CPU, RAM, Ethernet and real-time streaming are virtually indistinguishable between the two. But the latter retails for $400, the former for $500. Online extras are an additional $10 a year with the Xbox too. For the gamer not beholden to a particular format, Sony would seem to have an advantage, proven by the discrepancy in sales figures.

How important are those sales numbers, ultimately? Upon release, neither console had a dramatic effect on its parent company’s stock price. Microsoft (NASDAQ: MSFT) gained 3% within the week, but returned to its previous levels within another and has remained remarkably consistent since, as healthy Dow components do. Sony (NYSE: SNE) moved even less, with the graph of its stock price almost a horizontal line.

Shouldn’t a new console, let alone two, have a more pronounced influence in the market? It’s important to remember that although both the Xbox One and the PlayStation 4 are among the best-publicized consumer products in existence, that on its own isn’t enough to move the needle. The PlayStation 4 is the flagship product only of Sony’s electronics division, which is but one of four. Sony is also a motion picture studio, one of the “Big Three” music companies and, although this may surprise some non-Japanese, one of the world’s largest life insurance/financial firms.

The same goes for Microsoft. While the initial incarnation of the Xbox was groundbreaking upon its debut, and defined Microsoft as a major player in the video game industry, Xbox operations and ancillaries still make up only a modest part of Microsoft’s revenues. The Redmond leviathan remains, first and foremost, a software company. The latest release of Windows or Office doesn’t generate quite the buzz that a shiny new entertainment device does, but it does generate plenty of sales.

Three million Xbox One units at $500 apiece is $1.5 billion in revenue. This would be colossal for most companies, but Microsoft is in a different realm. Incredibly, and far out of proportion to its public footprint, Xbox One revenues make up less than 2% of Microsoft’s total for fiscal year 2013.

If you think that profit numbers are more pertinent here than revenue numbers, you’d be right – after all, if it costs little to create those Xbox Ones, the consoles’ impact on Microsoft’s bottom line would be large. Focusing on profit, however, shows Xbox One to be even less of a factor regarding Microsoft’s finances. The margin on each Xbox One unit? Less than 6%.

Sony isn’t making much more on its latest PlayStations, either. In fact, it's making less. One respected industry analyst claims that it costs $381 for Sony to make a $400 PlayStation 4, cutting the margins even more thinly.

Look to Games for Profits

So why even bother? Because the Xbox One and the PlayStation 4 are loss leaders. Or more accurately, small-profit leaders. Sales of the Xbox One and PlayStation 4 games are expected to dwarf those of the consoles themselves, by as much as a factor of 12. In fact, Activision Blizzard (NASDAQ: ATVI), publisher of Xbox One’s top-selling game (Call of Duty: Ghosts), spent $1.12 billion last year on products that it sold for $3.62 billion. There’s a reason why Activision and Microsoft have had a lucrative partnership for years. And why Killzone Shadow Fall, the best-selling game for the PlayStation 4, is produced in-house by Sony.

Price isn’t the only issue holding back the Xbox One with respect to the PlayStation 4, though. While the Xbox One (briefly) became the best-selling console in North America after its debut, it hasn’t been without controversy. In a world where hundreds of millions of people share their most personal information with Google and Facebook several times a day, Microsoft attempted to gather data about its customers’ gaming habits. The eighth-generation console initially required users to log into their accounts daily or lose the ability to play their games. The company then recanted after a public outcry, but that has yet to lead to a visible uptick in sales.

The real winner here (besides gaming consumers, who have more and greater choices than ever)? Probably Advanced Micro Devices (NYSE: AMD). The company that actually puts together the processors in each PlayStation 4 earns $100 per unit, which is far more than Sony itself does. That’s a welcome sign, given the semiconductor firm hasn’t turned a profit in two years.

The Bottom Line

Game consoles continue to delight customers more than they do investors. While Microsoft’s and Sony’s console operations certainly contribute to the bottom line, and perhaps offer intangible rewards not readily apparent in the marketplace, the companies are so impossibly large that the Xbox One and PlayStation 4 have but a small bearing on either’s fortunes.